Creation of Asset and Equity Bubbles and How They Lead to Periodic Crises

Why Periodic Crises happen and how they are being tackled now

The evolution of the global economy ever since the 1970s has been one of periodic crises and recessions along with failures of financial institutions that have taken a toll on the investors, and the layperson who has seen his or her savings evaporate and being forced to forego returns on whatever is left.

In recent months, the Western nations have proposed bail-ins, which essentially mean that the depositors in the banks would have to pay for any failures of the banks and not the taxpayers who would have to fund the bailouts.

In other words, the emphasis has now shifted from bailing out banks and financial institutions to asking depositors to foot the bill. The cause of all the examples cited above is too much debt at all levels of society.

While some amount of debt is needed for progress under capitalism, there has to be some check on the amount of debt that individuals, companies, and countries can accumulate. This trend had been the case since the 1970s when the policies of neoliberal capitalism and globalization started with the expansion of economic activity around the world.

The Creation of Asset Bubbles and Bubbles in every sector

The other aspect about the periodic crises that we have witnessed since the 1970s is the fact that asset and equity bubbles apart from all kinds of bubbles have been created that lead to inflation of prices, too much money flowing into the assets and the stocks along with other financial instruments. This trend has been encouraged by governments, economists, and corporatists who have stressed on the need to pump more money into the economy to stimulate growth.

Further, the absence of real wealth brought about due to the overemphasis on speculation and finance along with the gradual disappearance of manufacturing and physical wealth creation in the West had only exacerbated the problem.

The net result is that instead of creating real wealth, the West has been busy engaging in speculation and financialization with the result that when the bubble bursts like it did in 2008, the consequences are severe, sudden, and painful.

The west (especially the United States and Europe) are facing this reality, as they have to not only pay back the debt but also grow at the same time so that they can have enough money for the former as well as for the future.

The Root Cause of the Present Situation

The other cause for this situation is the decision of the United States under President Nixon in 1971 to go off the Gold Standard that pegged the value of the Dollar and the currencies of the world to the amount of gold held by them. With the currencies now freely floating without any anchor, the global economy has been characterized by inflation, asset bubbles, and bubbles in virtually every sector and component of the economy.

To understand how this would happen, imagine a person who can take debts only to the extent to which his assets can be backed up and used as collateral.

In this case, the individual’s debt would not exceed the value of the collateral or at best, it would be a few times more than that.

Now, imagine a scenario when this individual is told that he or she can borrow as much as he or she wants without having to provide collateral for the amount borrowed. The result would say that this individual would soon borrow as if there is no tomorrow and especially when one considers the temptations of consumerism that have emerged ever since the 1970s, it would be hard to resist except for the very strong willed to desist from accumulating debt to fund their lifestyles.

Concluding Remarks

Finally, the moot point about the present situation is that unless we return to real wealth creation and abandon excessive speculation along with risk financialization, we would be witnessing more crises that are periodic and deep in nature along with a Black Swan event where a sudden disruption is well and truly possible.

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